Ten years of records indicate that, by hedging fed cattle using the futures market, cattle feeders usually can lock in at least a breakeven price.
John D. Lawrence, associate professor of economics and director of the Iowa Beef Center notes that in Midwest feedlots, variation in the price of fed cattle, feeder cattle, and corn explains 74 percent of the variation in returns to feeding yearling steers compared with less than 10 percent due to variation in average daily gain and feed efficiency. Price risk, in other words, generally is greater than production risk.
Producers, Dr. Lawrence says, perceive two types of price risk:
- The risk of sinking the ship – the fear of losses, or accumulation of losses, large enough to put them out of business,
- The risk of missing the boat – the fear that if they do sell or hedge, prices may go higher later, and they will miss out.
Dr. Lawrence has analyzed ten years of data from the 1990s to compare how hedging strategies compared with cash prices. The data indicate that while missing the boat is a possibility, futures and options can reduce your risk of sinking the ship significantly.
During the 1990s, futures did reduce price risk. Hedging, Dr. Lawrence says, produced a higher minimum return and higher return at the 25th percentile (75 percent of the returns are better than this figure) than did the cash market. The 50th percentile, or median return, was higher for yearlings in the cash market than hedged cattle, and the calves had mixed results. Although the differences are not great, there have been months when the option strategies performed better than cash or futures. These include January through April and September through October. Then there are months when they did not fare well, particularly June through August.
Table 1. Percent of trading days during six month feeding period that breakeven or better could be hedged for yearlings.